10% Gain or Loss: Foreign Exchange Risk for Software Outsourcing
Outsourced software programming is growing quickly in today's software business with the use of Internet. The major possible advantage at client side is the lower cost and shorter turnaround. However, freelance programmers must consider exchange risk when providing the services. Negligence of this will result in losses.
When a U.S. company needs to hand out a site development project to engineers from India, the company may find Indian immigrants living in America already and make payment in US dollars. In this case there will be no exchange rate problem for the client. However, in most cases, resources in India homeland will be cheaper since the supply of service is adequate.
The U.S. client will usually compare offers from several potential Indian local service providers to determine the best price and quality. The U.S. buyer usually prefers to pay for the services in US Dollars, but the Indian engineers must pay local expenses in Indian Rupee. One of the two parties to the transaction will be forced to deal in a foreign currency. Either the U.S. client will end up paying in Dollars, with the Indian provider forced to convert the payment to Rupee. Or, the U.S. client will convert the Dollars to Rupee first and then pay the Indian provider. Since client has more bargaining power, client will decide the payment currency. US dollar, as home currency, will be used by American clients in most cases.
Another thing is payment term. When a work is finished, client need to check its quality and then deliver to next step such as send to webmaster to launch online. Then client will report to accounting department for payment. The larger the company, the slower the process. Usually 30-day or 45-day time need to be waited. Since the project itself will also take a certain amount of time to complete, depending on its size. Hence, the period between the order date and the actual receipt of payment can range from 3-6 months. At this point, the risk from exchange rate differentials comes into play, because rates are free to move up and down in response to changes in underlying economic conditions and the policies of individual countries.
Let's see several real-world data. The rate between USD/Rupee is around 39 at Jan 2008. It jumped to around 43 at the end of June 2008. So if an Indian engineer agreed to do a work in Jan 2008 for an American client and gets paid in USD till June 2008, his/her exchange extra gain will be as much as 10.26%! This percentage is not a small one. Of course, one party's gain means the loss of the opposite party. But situation will be totally different in 2007. In Jan 2007 the rate was 44 and it dropped to 40 by June 2007. For the same project, the Indian programmer will lose 9.1% due to Rupee's appreciation.
Freelance software programmers must be aware of the exchange risks and take some proactive measures to minimize the exchange loss due to exchange rate volatility. The first thing to do is to try to shorten the payment term. When planning tasks, especially if it is large-scale, set two or three payment milestones and get paid phase by phase. And then diversify the currencies. For example, using USD and Rupee (or Euro) in payment on a half-half basis will efficiently reduce the risk.
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